Today: The popularity of short sales | Tomorrow: Bye, bye heavy tax burden, hello debt relief

The setup

When times were good in the early to mid 2000s, loans were increasingly easy to get. Lenders opened up programs that allowed borrowers to qualify for loans that equaled 100% of the value of the home. Believe it or not, there were even programs that allowed for loans to exceed the home’s appraised value. After all, a home can only appreciate in value, right? Eventually, the home would be worth more than the loan, so what’s the big deal? Top that with the fact that many of these loans were given to unqualified borrowers “stating” their income. What’s more, these loans were often done as three and five year adjustable rate mortgages. Done the right way, none of the above is inherently “evil,” but when given out like candy to everybody that asks, it can spell disaster.

The result

What do you get when you combine 100%, interest-only adjustable rate mortgages with a market that couldn’t hold up? A lot of upside down homeowners. A $300,000 home with a $300,000 loan that becomes a $250,000 home while a borrower makes interest only payments becomes a likely candidate for foreclosure, especially when the homeowner’s ARM expires and adjusts to a rate that makes the monthly payment hard to afford.

A Better Option

A short sale may not allow for you to keep your home, but it does mitigate your losses and provide a “best possible outcome” scenario. While data is still sparse, it’s widely recognized that a short sale is less damaging to your credit. It’s also common for the lender to forgive your debt that accrued from a loss in value. Perhaps the biggest boost to short sale popularity was the passing of the Mortgage Debt Relief Act which temporarily stopped the IRS from taxing forgiven debt. Wouldn’t you like to be off the hook for that mounting debt, not have to pay exorbitant taxes on it, and limit your credit damage?

Short sales are especially attractive to those that hold an investment property such as a rental or vacation home. When you watch that property lose value and it becomes an unnecessary burden, getting rid of it is ideal. Of course, selling it at a price you need to recoup your losses is impossible. By applying for a short sale, you could potentially drop the price to a reasonable level and not be on the hook for the difference between value and loan balance.

What’s happening in the current market

A recent informal poll of the National Association of Realtors suggested that 18% of all home sales were of the short sale variety. As previously mentioned, data is still pretty new in this arena, so there’s not a lot else to go on. Many lenders are reporting huge increases in short sale activity. It’ not uncommon to see reports of a lender doing more short sales in one month than they did in all of 2007.

We’re likely to continue seeing dramatic increases in short sales over the coming months. Don’t get the idea that it’s easy, though. Not everyone qualifies and lenders aren’t just stamping “approved” every time someone applies. Consult a professional for a consultation.

Tomorrow: A deeper look at how the Mortgage Debt Relief Act has affected short sale activity.